Flying Kites

This week, the BRIC countries (Brazil, Russia, India, and China) conspicuously
gathered in Moscow for their first-ever economic summit. Although these countries
are divided by culture and geography, they are united by healthy economic growth
and their concern about unprecedented levels of U.S. debt and the safety of
their respective reserves. There can be no doubt that these emerging economic
powers are trying to chart an economic path that will free them from dependence
on the American financial system. And there is ample evidence that the first
coordinated steps are being taken.

Although their combined GDP represents only fifteen percent of the global
economy, these four countries together hold some 40 percent of the world's
currency reserves, more than half of which is denominated in dollars. As they
begin to openly question the continued role the U.S. dollar as the world's
official 'reserve,' attention should be paid.

The recent murmurs coming from Moscow were the second public expression of
growing dollar concern in less than six months. Only this past April, at the
G-20 meetings in London, China suggested that the U.S. dollar be replaced by
a gold-backed currency, administered by the International Monetary Fund (IMF).
China tactfully allowed its motion to die under a general G-20 display of unity
and goodwill. Likewise, at the G-8 meetings in Italy this past weekend, the
Russian Finance Minister, Alexei Kudrin, said, "the U.S. dollar's role as the
world's main reserve currency is unlikely to change in the near future."

'Flying kites' is a well-proven political technique for gaining gradual acceptance
of a new idea. In April, it was China alone who raised the first official prospect
of replacing the U.S. dollar as the world's 'reserve' currency. Now, China
has been joined by its fellow BRIC members. Both times, the idea was raised
and then tactfully dropped. But each time it served to erode confidence in
the dollar's role. It is likely that the next time the matter is aired publicly,
some OPEC members will also add their names.

It appears, therefore, that although support is continually ebbing, the U.S.
dollar will avoid a direct attack from creditor states, at least for now. But
investors should be aware of what led the mighty American dollar to be questioned
in the first place.

When President Bush entered office, the published U.S. Treasury debt was a
massive $5 trillion. He and Greenspan added a further $5 trillion by financing
the biggest asset boom in history.

Since then, President Obama has launched a massive socialist-style program
of bailouts, quasi-nationalizations, and stimulus measures orientated towards
even more entitlements -- at a projected additional borrowing cost of around
$2 trillion. At the same time, $2.5 trillion of Treasury debt has to be refinanced
this year, meaning the government will have to borrow a total of $4.5 trillion
in 2009 (even on the most optimistic assumptions). Despite this, the Fed had,
until recently, been successful in persuading the Treasury market that all
was under control, such that government bond yields held at surprisingly low
rates.

Now, however, there is increasing concern as to how the massive projected
budget deficits are to be financed without a steep increase in interest rates
and a resulting fall in current bond prices. Indeed, last Monday, in an attempt
to quell the negative sentiment, a top IMF official publicly professed that
the recent spike in longer-dated U.S. Treasury yields was not a sign of inappropriate
monetary policy.

In reality, there is increasing investor concern about potential depreciation
of the U.S. dollar, which may require the defensive action of sharply increased
interest rates.

The Chinese and Japanese together hold almost $2 trillion of U.S Treasury
obligations, or almost one-sixth of the total outstanding Treasury debt. As
the largest single holder, the Chinese are particularly concerned. Indeed they
have called for "special guarantees." The great, unspoken risk is that China
may slow or even halt its regular purchases of Treasuries, causing great damage
to U.S. interest rates. Worse still, China may wish to lower its risk exposure
both to U.S. inflation and to a forced increase in U.S. interest rates by switching
long bonds for short-dated bills. At worst, China could become a net seller
of U.S. Treasuries, putting great pressure on the U.S. dollar and American
interest rates.

Little wonder that U.S. Treasury Secretary Tim Geithner visited China recently
to calm nerves. We may never know what "special guarantees" Geithner promised
in order to prevent the Chinese from taking 'unhelpful' or even drastic actions.
Whatever they were, it is unlikely they will keep China quiet for long, especially
as the dollar's value degrades.

The U.S. dollar is clearly coasting on its legacy. The Obama Administration's
actions have eroded confidence to the point that the rapidly developing BRIC
membership has risked its own substantial stake in dollar investments to publicly
call for an alternative. These comments are the tip of the iceberg. Behind
the scenes, we can bet that creditor states are preparing for flight. Though
the dollar's slide has been stayed by pronouncements of confidence from Russia,
Japan, China, and others, there will come a time when the pain is too great
and the outcome too certain. Private investors who haven't already left the
collapsing dollar ballroom may be crushed when the big players stampede for
the door.

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John Browne is the Senior Economic Consultant for Euro Pacific
Capital, Inc. Mr. Brown is a distinguished former member of Britain's Parliament
who served on the Treasury Select Committee, as Chairman of the Conservative
Small Business Committee, and as a close associate of then-Prime Minister Margaret
Thatcher. Among his many notable assignments, John served as a principal advisor
to Mrs. Thatcher's government on issues related to the Soviet Union, and was
the first to convince Thatcher of the growing stature of then Agriculture Minister
Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously
pronounced that Gorbachev was a man the West "could do business with." A graduate
of the Royal Military Academy Sandhurst, Britain's version of West Point and
retired British army major, John served as a pilot, parachutist, and communications
specialist in the elite Grenadiers of the Royal Guard.

In addition to careers in British politics and the military,
John has a significant background, spanning some 37 years, in finance and business.
After graduating from the Harvard Business School, John joined the New York
firm of Morgan Stanley & Co as an investment banker. He has also worked
with such firms as Barclays Bank and Citigroup. During his career he has served
on the boards of numerous banks and international corporations, with a special
interest in venture capital. He is a frequent guest on CNBC's Kudlow & Co.
and the former editor of NewsMax Media's Financial Intelligence Report and
Moneynews.com. He holds FINRA series 7 & 63 licenses.